Wednesday, December 28, 2011

The
Government Accountability Office (GAO) recently released its 2011 Financial Report of the United States Government. I actually like this report;
since I have a business background, I find that it reads more like a corporate
annual report. In this case, the Financial Report provides the President,
Congress and Main Street America with a comprehensive look at how the Federal
Government is (mis)managing taxpayer dollars by outlining the Government's
financial position, its revenues, costs, assets and future liabilities.

That
sounds, well, rather sobering, doesn't it, especially since it's coming from a
former Fed President?

Here's
a snapshot of the condition of America's finances at the end of fiscal 2011 compared to:

If
you think of this as a report card for both the Presidency and Congress, one
would have to think that any teacher would assign a letter grade of
"F". Now, let's break down the data a bit further.

Here
is a graph showing the United States' budget deficits and net operating costs
for the past five years:

The
budget deficits of fiscal 2010 and fiscal 2011 were nearly identical at $1.294
trillion and $1.299 trillion respectively; a slight increase in revenue for
2011 and a decreased net cost (due to a drop in costs for federal employee and
veteran's benefits and a decline in the cost of economic recovery programs) led
to a drop in 2011 net operating cost to $1.313 trillion, down from $2.080 trillion
in fiscal 2010. Basically, it was the so-called "economic
recovery" that reduced overall net operating costs; when the economy heads
south again (as it surely will), net
operating costs will rise as they did between 2007 and 2010 as government tosses
more stimulus dollars into the pot.

The
GAO is quite concerned about the long-term fiscal challenges facing the United
States. Here is a graph showing the GAO's frightening fiscal projections for overall spending both including and excluding interest on the debt and revenue to 2086 as a percentage of GDP:

You
will note the massive increase in net interest spending as time passes. The
cost of the debt is expected to rise as a percentage of GDP even if both
federal government spending and receipts remain at a relatively stable 20
percent of GDP. Net interest costs alone will ultimately reach over 15
percent of GDP due to increased debt levels, a scenario that is most likely
unsustainable.

Now,
let's look at government revenues for 2011. First, the level of corporate
profits rose in fiscal 2011 but at a slower rate than in fiscal 2010. Despite
the rise in corporate profits, corporate tax revenue dropped by $4.5 billion
(or 2.5 percent) on a year-over-year basis as shown on this graph:

As
I've posted previously, you will notice how corporate tax receipts declined in
2011 despite the fact that the economy was improving. As well, corporate
tax receipts are less than half of their level in 2007, prior to the beginning
of the Great Recession.

The
level of personal income tax revenue rose by nearly $133 billion from fiscal
2010 to fiscal 2011, an increase of 7.7 percent. Personal tax revenue is
now at 90 percent of its pre-Great Recession peak in 2008 compared to corporate
tax revenue which is at only 48 percent of its pre-Great Recession peak in
2007. Perhaps corporations really do need a cut in the 35 percent levy! What
I find interesting is the 7.7 percent year-over-year rise in personal tax
revenue when one considers that the job market is hardly what could be termed
as robust; U3 unemployment was stubbornly stuck in the 9 percent plus range all
year and more comprehensive unemployment statistics showed unemployment levels
well in excess of 15 percent as the Shadow Government Statistics website shows here:

Now,
let's take a quick look at where Washington spent its windfall. Here is a
pie chart that breaks down where government allocates your tax dollars:

The
bulk of spending is in three areas, Department of Health and Social Services,
Social Security Administration and the Department of Defense. Each of
these consumes between 20 and 24 percent of Washington's revenue.

Here
is a graph showing Washington's assets and liabilities:

Washington
(or rather, taxpayers) owns about $2.707 trillion in assets comprised mainly of
property, plants and equipment ($852.8 billion) with the remainder in paper
including net loans receivable, those lovely mortgage-backed securities and
other investments ($985.2 billion). The problem with government assets
like property and equipment is that their value is often difficult to
accurately assess; for instance, what is the value of a National Park and is
there a even a market for such a property? On the liability side of the
ledger, Washington has $10.174 trillion worth of debt securities outstanding (Treasuries
plus accrued interest), Federal government employee post-employment benefits
and veteran's benefits totaling $5.792 trillion and other liabilities of
$1.526 trillion for total liabilities of $17.493 trillion. Doing the arithmetic results in net
liabilities of $14.785 trillion. On top of this debt, there is intragovernmental
debt which occurs when one part of the Federal government "borrows"
from another; this debt totals $4.7 trillion. This represents government
debt held by government trust funds including the Social Security and Medicare
Trust Funds which are required to invest excess annual receipts in Federal
government debt securities. Because these are liabilities of the Treasury
and assets of the Trusts, they cancel each other out.

From
the report, here is a graph
showing the projected non-interest spending by the government for the next few decades:

The
difference between non-interest spending and what the government takes in is
termed the primary deficit or primary surplus. You will notice the black line showing Washington’s total revenue
as a percentage of GDP; where the coloured portion of the graph rises above the
black line, there is a primary deficit (remembering that the primary deficit
excludes interest owing on the debt). The primary deficit soared in 2009,
2010 and 2011 as the government bailed out the economy (i.e. TARP et al). During
those 3 years, the primary deficit reached nearly 10 percent of GDP both
because of increased spending and decreased tax revenues. That is
expected to drop to the point where there is a small primary surplus between
2015 and 2019 as the spending reductions in the Budget Control Act kick in. The
primary surplus ends in 2020 as spending on Social Security, Medicare and
Medicaid rise; the primary deficit is expected to peak at 1.3 percent of GDP in
2035. You will notice that this projection does not include the
possibility of another Great Recession that would require a massive federal
government bailout as was the case in 2009 - 2011. That is why the black
line and the coloured areas are so smooth as we move into the future. Looking
back, one can see that the recessions of the early 1980s, 1990s and 2000s
resulted in far higher primary deficits than would have been projected prior to
their arrival. The same holds for the future with one difference; the increased
spending on entitlements will mean that the Federal government is starting from
a primary deficit rather than a primary surplus, making the fiscal situation
even more difficult to control.

As I
mentioned earlier, the GAO is concerned about the changing demographic that
will impact the fiscal picture in the future; America’s aging population will
result in persistent growth in Medicare, Medicaid and Social Security costs. Here’s
a quote from the report:

"Largely
as a result of the provisions in the Budget Control Act of 2011,4 the fiscal
outlook has improved. However, rising health care costs and the aging of the
U.S. population continue to create budgetary pressure. The oldest members of
the baby boom generation are now eligible for early Social Security retirement
benefits and for Medicare benefits. In addition, debt held by the public
continues to grow as a share of the economy; this means the current
structure of the federal budget is unsustainable over the longer term." (my bold)

According
to the Medicare Trustees' Report, spending on Medicare alone is expected to
rise from 3.7 percent of GDP in 2011 to 5.6 percent in 2035 and 6.2 percent in
2085. The Hospital Insurance Trust Fund is expected to remain solvent
until only 2024 after which time, tax income will only cover 90 percent of
benefits, declining to 76 percent
in 2050.
Social Security costs are expected to rise from 4.8 percent of GDP in 2011 to
6.2 percent in 2035 and declining to about 6.0 percent by 2050. The
Social Security Trustees' Report notes that the annual Old-Age, Survivors and
Disability Insurance Trust Funds (OASDI) income will exceed annual costs until
2023 at which point it will be necessary to begin drawing down the trust fund
assets until assets are exhausted in 2036. After funds are exhausted,
tax income will cover only 77 percent of benefits in 2036 and 74 percent in
2085.

Let’s
look at what happens to growth in the primary deficit as a percentage of GDP if
health care cost growth is more rapid than projected:

If
Medicare and Medicaid expenses grow just 2 percentage points faster than the
GAO projects, the primary deficit (excluding interest on the debt) reaches 20
percent of GDP by 2085. This doesn't sound like much until you put the number into
perspective. Right now, the entirety of Federal government spending as a
share of GDP, once again excluding interest on the debt, is 22.6 percent. To
put the deficit into dollar terms, the 75 year present value fiscal imbalance
of this 2 percentage point increase in Medicare and Medicaid spending is a
rather scary $66.5 trillion or just over 4 times the current level of the entire
federal debt.

When
we take all of this data into consideration along with projections for interest
rates and GDP, here is what we end up with:

Over
the next 75 years, the debt-to-GDP ratio is projected to rise to 283 percent,
down markedly from the projections of 352 percent in last year's Financial
Report, largely because of spending reductions called for in the Budget Control
Act of 2011. While this may appear to be a meaningful improvement, a
projection is just that, a projection.
From the graph showing what happens when spending on Medicare and
Medicaid increase by just 2 percentage points, you can see how sensitive the
projections are to small increases in spending or declines in revenue.

The
sooner Congress makes meaningful progress towards fiscal consolidation, the
less painful it will be for America. If reform begins in 2022 rather than
immediately (assuming an immediate reform of 1.8 percent of GDP), the primary
surplus must be raised by 2.2 percent of GDP, by 2032, the primary surplus must
be raised by 2.8 percent of GDP just to keep the debt-to-GDP level in 2086 equivalent
to the level in 2011. The increased cost incurred by delaying is a result
of rising interest on the rising debt level.

Let’s
close this rather lengthy posting with one last quote from the report:

"If
a higher debt-to-GDP ratio increases the interest rate, making it more costly
for the government to service its debt and simultaneously slowing private
investment, the primary surplus required to return the debt-to- GDP ratio to
its 2011 level will also increase. This dynamic may accelerate with higher
ratios of debt to GDP, potentially leading to the point where there may be
no feasible level of taxes and spending that would reduce the debt-to-GDP ratio
to its 2011 level." (my bold)

17 comments:

that's one side of the story; however, US debt has another side; every dollar borrowed is an asset on someone else's books...what's important to understand is that short term US government debt has become, at least in part, the worlds money supply; a million dollar Treasury bill is used as money by the international banking system and by sovereign wealth funds in the same sense that you use a ten dollar bill in your wallet…thus, any contraction of the supply of the reserve currency (our treasury debt) has a negative impact on the world economy in the same manner that a contraction in the domestic money supply impacts our nation's economy...

@rjs, I hope there is some other way for the world money supply to increase aside from increasing the debt of US taxpayers.

@PJ, Regarding the second chart about the budget deficit and net operating cost, do you know whether the 2007-9 figures include over-budget items such as war costs? I recall that Obama said that he would put such costs into the budget, but reports rarely discuss this, so I don't know if I'm getting fair comparisons year-on-year.

moderate poli, by referring to "increasing the debt of US taxpayers" suggests you believe that taxpayers ultimately have to pay the debt back; but that's not the way US debt has been historically handled; typically, we've grown out of our debts:http://econospeak.blogspot.com/2011/12/meme-that-refuses-to-die-government.html Dr Randall Wray has shown that in each of the 6 times in US history where we had a depression, it was preceded by substantial budget surpluses and significant reduction of the debt; this was a concern of the Fed & bush administration economists early last decade; it became clear that if clinton surpluses continued & our debt was paid down, the financial system would soon experience a dearth of safe assets & would begin to lock up; so the bush tax cuts were initiated in order to keep levels of AAA assets high enough for the markets to operate...http://www.asymptosis.com/does-reducing-the-federal-debt-cause-financial-collapse.html

So now we have a depression preceeded by a huge deficit. btw, Saying that a depression is preceeded by a period of budget surpluses amounts to saying that a depression is preceeded by a period of strong economic growth. It is the ultimate BS argument. The Bush - Greenspan cabal didn't make much sense at the time, worrying about the end of AAA assets, and it still doesn't. If the USA looses its AAA rating, which is not impossible anymore, the world will really face a dearth of AAA assets, and the sun will still rise in the East every 24 hours.

@rjs, I have to call you on a extremely weak argument. When you say the 6 US depressions were preceded by reduction in debt, you neglect to point out that these depressions date from 1819 to 1929. Excuse me for scoffing at 19th century data to guide current decision-making.

You still haven't answered how US taxpayers will pay back the debt, and even keep making the interest payments, at PoliticalJunkie points out.

You may believe the US can grow its way out of our massive debt, but the last decade don't give most of us a lot of reason to believe that. To be plainer, you have a lot of wishful thinking going on.

All arguments aside, what I find particularly telling is, that even the GAO and the Treasury Secretary are admitting that the situation is dire at best and critical at worst and certainly unsustainable. Just as in the case of individuals and other nations, bankruptcy/default is always an option. It's just that in this case, should the United States ultimately default because the level of debt and debt interest is unserviceable, the result will be very, very ugly.

The cost of servicing the debt was lower in 2011 for one reason - ultra-low interest rates - see my posting here:

That will not always be the case. Eventually, the world's bond markets will assess the current risk attached to Treasuries as being too low, prices will fall and rates will rise. That's the point I was trying to make in the aforementioned posting.

ModeratePoli - I don't know about including the war effort - I know that DoD is included. I'll have to look back at previous reports to see. I know that TARP et al was included and that's why operating budget costs were higher in 2009 - 2010.

a sovereign that issues its own money need never be concerned about deficit; it should concern itself with getting its economy functioning at its capacity, at which time the deficits take care of themselves..

i judge a system by its results, not by the numbers one moves around on spreadsheets...& an economic, financial & political system that idles nearly one-fifth of its citizens & has another fifth working below their capacity is a failure...

rjs also discounts the opinions not only of the GAO, nd the Treasury.The CBO has had many papers stating this growth of debt is unsustainable.But, don't worry, rjs has his sources, too!My grandfather had a saying:What you owe, you owe.What you own, you may not own.That is wisdom for everyone, including "sovereign" governments.The debt can get out of hand, that its so-called sovereignty and full faith and credit is jeopardized.Or, is that impossible, rjs?Don Levit

@ajs, how many arguments are you going to make me debunk? Earlier you trotted out the argument that paying down debt causes depression, but you didn't bother to note that the assertion was based on data from the 19th century.

This time you trot out a graph, but you don't do one iota of analysis. Your graph shows debt surging during wars (and the depression). There's a big difference between running up debt for national emergency and running it up for ongoing standard expenses.

I agree we'll survive this debt, but the cost in the quality of our lives, or our children's lives, might be quite high.

Plus you still haven't touched the numbers on how we'll manage debt service, or what we'll be giving up to pay debt service.

calling names is just ignorant...if your grasshopper reference is to the fable, i paid off my own house in the early 80s & have been personally debt free since...governemnt debt is not at all like personal debt...thats a fallacy of composition (look it up)

dont bother replying to me; i am unsubscribing to this comment thread...

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.